Local Revenue Hills: Evidence from Four U.S. Cities

We provide estimates of the effects and long-run elasticities of the tax base with respect to tax rates for four large U.S. cities: Houston (property taxation), Minneapolis (property taxation), New York City (property, general sales, and income taxation), and Philadelphia (property, gross receipts, and wage taxation). Results suggest that three of our cities are near the peaks of their revenue hills; Minneapolis is the exception. A significant negative effect of a balanced-budget increase in city property tax rates on the city property base is interpreted as a capitalization effect and suggests that marginal increases in city spending do not provide positive net benefits to property owners. Estimates of the effects of taxes on city employment levels for New York City and Philadelphia'the two cities for which employment series are available-show the local income and wage tax rates have significant negative effects on city employment levels. Cuts in these tax rates are likely to be an economically cost-effective way to increase city jobs. High taxes, sometimes by diminishing consumption of the taxed commodities, and sometimes by encouraging smuggling, frequently afford a smaller revenue to government than what might be drawn from more moderate taxes. (Adam Smith, The Wealth of Nations, book V, chapter II.)It is a signal advantage of taxes on articles of consumption that they contain in their own nature a security against excess. If duties are too high, they lessen the consumption; the collection is eluded; and the product to the treasury is not so great as when they are confined within proper and moderate bounds. (Alexander Hamilton, "Further Defects of the Present Constitution," Federalist Papers, No. 21.)If a tax is gradually increased from zero up to the point where it becomes prohibitive, its yield is at first nil, then increase by small stages until it reaches a maximum, after which it gradually declines until it becomes zero again. [Jules Dupuit, "On the Measurement of Utility from Public Works," reprinted in K. Arrow and Tibor Scitovsky, Readings in Welfare Economics (Homewood, IL: Richard D.Irwin, 1969).]Nor should the bbargument seem strange that taxation may be so high as to defeat its object, and that, given sufficient time to gather the fruits, a reduction bbbbbof taxation will run a better chance than increase of balancing the budget. (John Maynard Keynes, Collected Works of John Maynard Keynes, St. Martin's Press, p. 338.) © 2004 President and Fellows of Harvard College and the Massachusetts Institute of Technology.